Is an Annuity the Same as a Pension?

The Difference Between Annuities and Pensions

In broad terms, the main difference between an annuity and a pension is that you buy an annuity after retirement to provide you with a guaranteed regular income, whereas you save into a pension pot throughout your life.

You can use your pension pot to supplement the state pension you receive from the government at state pension age.

Although many people think of a pension as something they receive after they retire, technically that’s not the case.

A pension is the pot you build up throughout your working life. This might be either a defined contribution pension or a defined benefit pension.

A defined benefit pension pays you out a regular income for life after retirement. With a defined contribution pension, you have to turn your pot of savings into a retirement income when you want to stop working. There are a number of different ways to do this.

Pension Drawdown vs Annuity

For a defined contribution pension, also known as money purchase pensions — which I assume you have as you’re considering buying an annuity — you have two main options at retirement. These are:

• Buying an annuity
• Entering pension income drawdown.

When you buy an annuity, you exchange all or part of your pension pot for a regular retirement income for life. This income is protected against investment risk and can be index-linked so that it rises with inflation.

However, if you want your pension pot to remain invested throughout retirement, giving it the chance for investment growth, an annuity may not be for you.

A more versatile option in how you take your income would potentially be drawing down your pension. Here, you can take cash lump sums and/or income payments from your pension pot as you see fit.

The rules around inherited drawdown pensions offer greater flexibility than is the case for an annuity, also.

However, the major risk of drawdown is that your pension pot is finite and could run out if you live longer than expected, you take too much, too soon from your pension or your investments don’t perform as well as you expected.

So while the difference between an annuity and a pension is that an annuity is typically bought with your pension pot, buying an annuity is not the only option. Nor may it necessarily offer the best retirement income provision for you.